Advisors Posts

Steve Blank: “What I began to realize is that we teach entrepreneurship like every vertical market and industry has the same set of rules. So the first heuristic I want to offer is that — even in this class — there really is no common ‘these rules work’ for all vertical markets and industries.”

Listen to this excerpt from the second class of Steve’s customer development course for the rest of this wonderful lesson.

We teach entrepreneurship like every vertical market has the same set of rules

Steve Blank: How many are in Web 2.0? Like the social something web. How many are in enterprise software? Anybody in semiconductors? EDA? OK. Is there a biotech guy still here? Oh!

One of the interesting things about when I put up the fact that there are different industries or markets, everybody goes, “Well, yeah. Of course.” I’m going to tell you a very funny story.

When I started teaching in the engineering school of the school not-to-be-named down south, but it starts with an “S,” I formed teams just like you guys are going to do for projects. And I’d always say, “Listen, anybody can start a company. All you need is a half a million bucks.” OK, yes, sir, a half a million bucks. Write that down.

Next week there’s always a group that looks like these three people, that says, “Startup, half a million dollars.” It’s a divide by zero problems here, because in our business they’d come back and say, “Hey, Professor Blank, in our business the common wisdom is $100 million.”

And then I’d go, “Oh, well, yes of course, you’re in the life sciences, that’s completely different.” The next week I’d say, “Except for these guys who need $100 million, you ought to get out and start selling your product on day one, because you don’t need to worry about any IP at all. Web 2.0. Just go out and get out there.”

The next week someone raises their hand and says, “Professor Blank, in our industry there’s a ton of patents and stuff and people tell us we shouldn’t be out there unless we start patent protecting all our stuff.”

And I went, “Oh, oh, oh, you’re in a different vertical market. In that vertical market you’re absolutely right. But OK, let’s keep going on with the class. The rest of you guys can keep going out because you don’t need to worry about anything, about government regulation or anything. It’s a startup. Just go out there. There’s no regulation to worry about.”

The next week it’s a group that comes up and says, “Professor Blank, we’re doing a medical device and there’s something called the 510K, and that’s a two-year process.” And I go, “Oh, oh, for those of you in medical devices…”

And what I began to realize is that we teach entrepreneurship like every vertical market and industry has the same set of rules. So the first heuristic I want to offer is that even in this class, there really is no common “these rules work” for all vertical markets and industries.

And the first heuristic I want you to think about is, when you hear common advice from friends or other people who’ve done startups, always ask what industry were they in, and was that particular advice relevant for me or not.

I think, I’ve probably screwed up a startup in almost every one of these. That was a joke.

Did I miss anybody’s vertical market? Anybody here who I didn’t kind of get? All right. So this is not meant as a comprehensive list, but usually it takes about 95% of those students in the room.

Technical risk vs. market risk

Steve Blank: Now what’s interesting is if I ask you, Eric, in your biotech startup, what’s your greatest risk? What is it?

Eric: Our team is working on an asthma inhaler.

Steve: Right. So what’s the biggest risk?

Eric: The efficacy.

Steve: Right. The efficacy of what?

Eric: The efficacy of the drug and its impacts. That’s a big risk.

Steve: So whether the product, as envisioned, works at all.

Eric: Right. And even if it works, are the adverse effects….

Steve: Does it kill you?

Eric: Yeah. Not to put too fine a point on it.

Steve: It’s a very nice clinician’s way of saying did it kill him or did he grow a third arm. How about you guys, do you have a particular drug or product in mind?

Student: The technology similar to some medical devices, the bio-monitoring… interactions.

Steve: So whether biomarkers are predicted, for a predictor from an assay you’re thinking about making.

Student: Yes.

Steve: So it’s a technical risk, right?

Student: Yes.

Steve: How many of you are thinking about a Web 2.0 startup? Great. What’s the risk, Josh? What’s the product?

Josh: It’s a digital media company.

Steve: Perfect. What’s the technical risk?

Josh: Finding the engineers.

Steve: Right. Is that a risk in Silicon Valley?

Josh: There’s not a lot of risk.

Steve: What’s the risk?

Josh: Getting people to use it.

Steve: Interesting. If our drug works for asthma, or your friends drug, does he have a customer problem?

Josh: No.

Steve: Why?

Josh: Because there are a lot of people that need….

Steve: If you’re running out of air, you’re going to probably want your drug, right? But you have a different problem. You could almost say, unless we really are stupid, we’re not going to screw up the technology. Wouldn’t you love it, if you were these guys, to be able to say that?

Josh: Yeah.

Steve: Big idea here. It’s a big idea, one that I’ve never heard articulated before at all with startups, yet world-class VCs know this on day one. There are some industries where the risk is purely customer in market.

And by purely I just mean, in Silicon Valley we take for granted digital media and web, with all due respect, for the hard work your software engineers are going to do getting it up, it’s not invention.

It’s, gee, did, they do it efficiently or did the Oracle salesman convince them to buy half a million bucks of software they didn’t need. But it’s not invention.

There’s a whole other set of industries where it truly is invention. Where it truly is, we should be so lucky to get this product working. Because if we get an asthma drug or an oncology for cancer curing drug, our only problem is how big is the licensing deal going to be? And not whether customers are going to want this.

Is this distinction clear? When you start a company, question one to self. Memo to self. Am I in a market risk company? Or am I in an invention risk company?

Hybrid risks

Steve Blank: And by the way, I said this in the first class, I’ll remind you again, though. I’m happy to have every one of you in the class, but if you are in an invention risk company, now I’ll talk about hybrid companies in a second. Invention risk company, this class can offer you nothing.

To the extent that, what customer development is about, is how to dramatically reduce market risk. It is not how to reduce invention risk. So if I lose three of you next week. But you’re more than welcome, I just want to understand…

Student: I’m a hybrid.

Steve: I’m sorry?

Student: I’m a hybrid.

Steve: You’re a hybrid. And I’ll talk about hybrids in a second. Is that clear so far? Memo to self, duh! Can we assume the technology works and our problem is whether the product and market fit is correct? Or is in fact, the product itself the risk factor. But I have something says both.

Give me an example of a vertical market or an industry that has both risks.

Student: Semiconductor?

Steve: Perfect. Why?

Student: Because the technology is fairly advanced. There’s a lot of new insight there. But then the customers are very finicky, maybe, in the type of devices…

Steve: Let’s get specific. What kind of semiconductors do you have in mind? That has technology risk.

Student: Say, consumer electronics or…

Steve: Give me more specific than that. Anyone else in the semiconductor business? You raised your hands in the beginning, now you’re hiding. Yes?

Student: Yes, the industry I work in, we target what the customers want.

Steve: Right, so give me a specific case of technology risk in semiconductors.

Student: Like a high speed serial interface.

Steve: Perfect. OK. Or better, a new graphics architecture, or a new CPU architecture, or you’re making a new IBM cell architecture. Yeah, that’s on the bleeding edge. We don’t even know if the architecture is going to work. Right? I just want to be clear.

Semiconductors, if you’re just making a faster version of some one else’s chip, you’re not taking too much technical risk, are you? I mean, whether you can push it faster.

But typically in semiconductors, if you’re taking architectural risk, if you really have some insight you believe, or communications hardware.

Pushing the envelope is usually about how deep you can go into packet inspection, to how fast and et cetera. Those are some pretty serious trade-offs. You don’t know if this stuff works until you get first use out of the way. Is that fair?

Student: Yep.

Steve: That’s the technical risk. What’s the market risk in that kind of semiconductor business? What’s the customer risk there? Anybody? You don’t even have to be in the semiconductor business. Yes.

Student: For example, they could really mean technology. They could build a chip.

Steve: Yes.

Student: But for some reason, in benchmarking for the system provider assistance is another. Another vendor. Or even more, the old standard just doesn’t pick up.

Steve: Right. So you could have a neat, new architecture, but your competitor could kick your butt. By convincing all the platform people who have to design your product in, “Oh, listen. That’s so incompatible. It uses 62 Hz, rather than 60 Hz of electricity. You’ll never be able to use it.” By the way, I once convinced an entire industry of that, but that’s another story.

So you could win on technical risk, and lose in market risk in hybrid technology. Give me another example. I picked Semiconductors. What’s another one?

Student: I used to do R&D groups with Blu-ray.

Steve: Perfect, talk to me.

Student: I don’t know much about it, but basically from a technical stand point, it seems like you’re pretty similar technology. But it obviously, Sony and company convinced the company prior to movie studios that they’re better off just shipping their content with Blu-ray rather than the DVD medium.

Steve: So this was the next standard for DVD’s. Right? For the last three or four years. Huge battles over who would be the supplier. Lots of chess games, lots of technical risk.

Because even at the end, they were still playing games with the spec and adding more security layer and what ever. At the end of the day, Blu-ray won. Didn’t win on technology, it won because they finally got a critical mass of people to design in the product.

Now the irony is, who do you think might actually, ultimately win? Who may undercut?

Student: Streaming Hi-Def?

Steve: Streaming Hi-Def. Right? It might be that the current DVD standard might have been the last one that sold upon these that it is. Most people, certainly my kids, don’t go out and ever buy DVD’s.

They download stuff to their iPods or Macs or some thing else, or to streaming video. Oops. They’re all an investment. You might have just built the product that no one else wants.

So I just want to point out that when you look at a startup, ask those fundamental questions on day one. What problem do we think we have besides who are we, what business are we in, and what ever. It’s like, are we going to be risking trying to understand our customers and we ought to try to focus on that.

Or is the focus truly inside the building. Because Steve, it doesn’t matter what customers think unless we really nail this technology. None of this matters.

“Decisions tend to be judged solely on the results they produce. But I believe the right test should focus heavily on the quality of the decision-making itself…

“Individual decisions can be badly thought through, and yet be successful, or exceedingly well thought through, but be unsuccessful, because the recognized possibility of failure in fact occurs. But over time, more thoughtful decision-making will lead to better overall results, and more thoughtful decision-making can be encouraged by evaluating decisions on how well they were made rather than on outcome…

“It’s not that results don’t matter. They do. But judging solely on results is a serious deterrent to taking the risks that may be necessary to making the right decision. Simply put, the way decisions are evaluated affects the way decisions are made.”

Rubin looks at the world through the lens of probabilities. A good decision might have bad results. But if you have the chance to do it all over again, under the same conditions, you should make the same decision.

Evaluating advisors

“Any time you make a bet with the best of it, where the odds are in your favor, you have earned something on that bet, whether you actually win or lose the bet. By the same token, when you make a bet with the worst of it, where the odds are not in your favor, you have lost something, whether you actually win or lose the bet.”

Evaluate advisors on the quality of their decision-making, not on the quality of their past outcomes. The same goes for advice from investors, or anyone at all.

Entrepreneurs and investors can make poor decisions and still succeed. They can get lucky. But the odds that the same thinking will work at your company aren’t favorable.

Other startups can make great decisions and still fail. They can get unlucky. But their thinking wasn’t bad — they just need to roll the dice again.

Evaluating decision-making

“Simply put, the way decisions are evaluated affects the way decisions are made.”

– Robert Rubin, Ibid.

This is the coolest part of Rubin’s speech.

First, we evaluate decision-making processes and pick one. Second, we execute the process and get a decision. Third, the decision leads to action, which leads to an outcome. (All of these steps can be iterative.)

Does anyone actually evaluate decision-making? Yes. Often it’s implicit. For example, a job interview is an evaluation. A candidate has a decision-making process whether he knows it or not. And an interview evaluates a candidate’s decision-making process whether a startup knows it or not.

The decision-making process you pick is more important than the decisions it produces. And the way you evaluate processes is more important than the process you pick. Evaluation is king.

Evaluate decision-making processes based on their quality, not on a handful of their outcomes. For example, consider whether job interviews are an effective way to evaluate a candidate’s decision-making. In other words, (evaluate (processes for evaluating (processes for making decisions))). In other words, duh.

Advice can be ignored. One of my favorite advisors once told the founders of YouTube that, “People don’t want to watch video on their computers.”

Advice is useful if it helps you perceive and evaluate the outcomes of today’s actions. That’s what it means to be wise. But advisors can’t be wise for you, especially since they don’t know your values, goals, and environment.

Understanding advice isn’t as useful as understanding why you’re supposed to be following it.

Advice tells you how to play the game. But there’s more than one way to play the game in chess, football, business, and life.

Advice distills the experiences of the past. But what worked yesterday will not work tomorrow. Today is not for copying the past. Today is for testing hypotheses whose outcome is unknown.

Advice asks for mimicry: “This works for me so you should do the same thing I do.” But the essence of strategy is to perform different activities than your rivals do. Strategy requires differentiation—not mimicry.

Once you’ve gathered advice, take the course that you think is best—you’re the only one who will be faced with the consequences.

Lawyers teach you the rules of the game. But they usually can’t teach you how to play it.

Lawyers say whether you can do something, within the confines of the law and your existing contracts. Lawyers will also write the contracts and do the filings. But they usually can’t tell you what to do—that’s what coaches do.

Here’s a classic startup mistake that illuminates the difference between a coach and a referee:

You’re negotiating an investment and you’ve agreed to a board with 2 investors, 2 common, and 1 independent.

You’re almost ready to sign the term sheet when your prospective investors say, “Sorry, we forgot, one of the common board seats needs to be the CEO.”

You’re thinking, “I’m the CEO and I was going to elect myself to the board anyway, so that’s fine.” Your lawyer agrees and says, “That’s standard.”

A lawyer knows that you’re not breaking any laws or contracts if you give a common board seat to a new CEO. He also knows how to write the contract. But an advisor knows the possible outcomes of that decision.

Third, startups without advisors often assume their lawyers have good business advice. That’s a mistake. You need a coach, not a referee, to teach you how to play the game. And most referees aren’t good coaches (but some are).

Fourth, not every coach is a Phil Jackson. Not every coach has won 9 NBA titles as a coach. The effectiveness of coaches in the NBA varies widely. Why would the effectiveness of advisors be any different? Is your advisor a Phil Jackson?

Fifth, there’s more than one way to play the game. Phil Jackson doesn’t have a monopoly on coaching. And neither do we. Go find a coach who can teach you how to play the game. There’s only one Phil Jackson in the NBA because basketball is a zero-sum game. Fortunately, there’s more than one great startup advisor in the world—life is not a zero-sum game.

Compensation

7. What should I pay advisors?

Nothing—get them to pay you. Ask advisors to invest. You get money, save stock, and amplify the advisor’s social proof in the process. But lots of good advisors can’t or won’t invest, so…

7.5 What should I pay advisors if they won’t invest?

Advisors are not paid by the hour—they’re paid for results. They’re not paid for their inputs—they’re paid for their outputs. If an advisor can uncork a million dollars of your company’s latent value with 15 minutes of conversation or a single introduction, you should pay him appropriately.

There are roughly two types of advisors—we’ll call them the normal advisor and the super advisor.

Normal advisors

The normal advisor gets 0.1%-0.25% of a company’s post-Series A stock. Normal advisors do something important for the company and aren’t expected to do much beyond that. For example, they introduce the company to a key customer or investor.

Normal advisors are also assembled by naive entrepreneurs who think the mere presence of an advisory board will create social proof and help them raise money. But investors don’t take these mock advisory boards seriously.

Super advisors

The super advisor can get as much stock as a board member: 1%-2% of a company’s post-Series A stock. Super advisors help make your company happen. They know all your prospective customers intimately. Or they raise your money for you. Or they bring you a handful of great employees. They can even add more value than an independent board member because they don’t have to deal with corporate governance.

If you find a super advisor, you want to incent him as much as possible and push him to help make the company happen. They can be much more effective than 5 or 10 normal advisors.

Most super advisors are unique and Y Combinator is a great example. YC takes about 6% of a company in return for $15K-$20K. Although most of their companies can survive with the small investment, the money is effectively meaningless—it’s an artifice. Most of their companies would probably give 6% of their shares to YC for free, just to participate in the program.

YC acts like a super advisor, not an investor—and YC makes their companies happen by helping develop the company’s product, introducing them to investors, and branding their companies.

Advisor compensation

Whether you’re hiring a normal advisor or super advisor:

Advisory shares are usually issued as common stock options.

The options typically vest monthly over 1-2 years with 100% single-trigger acceleration and no cliff. Although the advisor is on a vesting schedule, you should expect them to add most of their value up-front—that’s normal.

If your company hasn’t raised a Series A, increase the advisor’s equity by roughly 30%-50% to account for dilution from seed investors, Series A investors, option pools, swimming pools, and the like.

Finally, there is a beauty to paying in equity rather than an equivalent amount of cash. If you pay for a service in cash and you want that service again, you have to pay again. If you pay in equity, you pay once and keep getting served ad infinitum. Equity is the gift that keeps on giving. Your shareholders own you, but you also own them.

8. What are advisory shares?

Advisory shares are normal common stock. There is no legal concept of ‘advisory shares’. The Supreme Court has never heard a case regarding advisory shares. Chief Justice Roberts doesn’t give a shit about advisory shares.

9. Why should I pay advisors?

“Make sure that, for the people that count to you, you count to them.”

If someone helps your company succeed, it is only fair to share that success with them. If you want to do repeat business with people, you need to treat them right the first time around.

Equity also keeps advisors on the hook: you can go back to them again and again for help. If they were helpful once, they can probably be helpful again. And people with a financial interest in your future tend to return your calls.

Equity also incents advisors to keep working for you in the background whether or not you ask them to. They’ll bring you leads for customers, employees, and investors.

If you’re an advisor, don’t do it for the money. The opportunity cost is probably too high. You want to get paid so (1) you can own a little piece of the company in case it happens to be the next Google and (2) so the company signals that it values your time and contribution.

10. When do advisors get terminated?

Advisors can get terminated when they don’t add value at the level they originally agreed to. They can also get terminated if the company is “reset”, e.g.

You hired a video game expert because you were building a video game but now you’re building a photo sharing site. The company has left the line of business where the advisor added value.

A naive entrepreneur hires the wrong business advisor and a major new investor asks the entrepreneur to clean up the dead wood.

The company is acquired, recapitalized, or otherwise restructured and the advisors are no longer useful or desired.

11. Should I give advisory shares to my investors?

Angels or seed investors may ask for advisory shares. They might argue that they will be more helpful than the other investors, so they should get advisory shares.

But every investor thinks he will add more value than the other investors. We would like to propose a shareholder’s code of conduct: if you think you’re doing too much, you’re probably just doing your share.

So, how do you decide whether you should give advisory shares to an investor?

First, determine how many shares you would give him if he were just an advisor. Then subtract the number of shares he is buying with his investment. If the balance is significant, say, more than 50% of the shares he is buying, give him the balance in advisory shares. If the balance is under 25%, the additional shares won’t really matter to the investor and they aren’t worth the trouble of trying to justify the advisory shares to the other investors.

(This is why you never give advisory shares to venture capitalists nor do they ask for them: the balance for VCs is zero since they are buying so much of the company anyway.)

If the balance is not significant, you should just say no:

“All of our investors will be advising the company. That’s what good investors do. If I gave you advisory shares, I would have to give them to all the investors. And that wouldn’t make any sense—our valuation already takes the investor’s value-add into account.”

But if the balance is significant, you need an argument that makes sense to the other investors or they will also ask for advisory shares and lower your effective valuation:

“We want to hire him as an advisor. Fortunately, we don’t have to give him all the shares for free because he’s also going to invest as much as he can.”

You have to be able to convince the other investors—that’s the test. Or you can just “burn the boats at the shore” and give the advisory shares to the investor with the agreement that he will invest a minimum amount in the financing.

General

1. What do advisors do?

They provide advice, introductions, investment, and social proof. Any combination of these is useful, except for an advisor who just provides social proof—savvy folks don’t take those advisors seriously.

2. Should I put together a board of advisors?

A “board” of advisors is not a formal legal entity like a board of directors, which is defined in the Constitution and shit. You don’t need a board to collect advisors.

Create a board if it makes you and your advisors happy. Perhaps some advisors feel fancy if they’re on a board. But it really doesn’t mean anything.

3. How do I get good advice?

Ask questions. I usually ask questions about my immediate goals for the next day and week. This sounds obvious but most people simply don’t know how to get good advice and apply it.

Some entrepreneurs set up quarterly advisory board meetings and that probably works well for them. But we find savvy entrepreneurs tend to be transactional—they ping their advisors as needed and skip the advisory board meetings.

4. How do I apply advice?

Your advisor isn’t you: he doesn’t have your goals, history, or strengths and weaknesses. He doesn’t know your company like you do. So take the advice and apply it to your specific situation. This is the advisor paradox: hire advisors for good advice but don’t follow it, apply it.

Even good advisors may guide you with conventional wisdom. And startups are about applying unconventional wisdom. Your task is to hire the maverick advisors in the crowd.

5. How do I find advisors?

From your network and cold calls. There is no magic solution. Hiring advisors is an ongoing effort. Start now and continue until you’re dead.

If you’re working on something interesting, smart people will offer to help you. The contrapositive is also true: if smart people don’t offer to help you, you’re probably not working on something interesting.

Personally, I’m always asking people for advice. I try to turn the folks that give great answers into advisors.

6. How can I tell if an advisor is any good?

Try before you buy. Most advice is awful. Including advice from successful entrepreneurs. (Successful people probably have an intrinsic lead on making introductions though—they tend to have better networks.)

If you’re considering a prospective advisor, (i) talk to his other advisees and find out exactly what he’s done for them, and (ii) get some advice or introductions first. Then hire him if you like the results. No worthwhile advisor will resist this test.

You can gauge the quality of advice by asking questions (see above). Does the prospective advisor give you the best answers you have ever heard? Could he teach a course at Harvard on the topic? Would you invest in him? If no, move on. If yes, engage him and squeeze his brain dry.